the five critical components for successful reit investing...for broker-dealer use only...

FOR BROKER-DEALER USE ONLY FOR BROKER-DEALER USE ONLY BD-HC216(040113)

The Five Critical Components for

Successful REIT Investing: An Advanced-level Review

FOR BROKER DEALER USE ONLY. THIS IS NEITHER AN OFFER TO SELL NOR A SOLICITATION OF AN OFFER TO BUY ANY REIT. AN OFFERING

IS MADE ONLY BY THE PROSPECTUS.

ACR #113894

FOR BROKER-DEALER USE ONLY BD-HC216(040113) 1

Investing in REITs involves a high degree of risk and investors should also carefully consider the information set forth in the prospectus prior to investing. Such information that may be provided in a prospectus includes the following but not limited to:

• There is no public market for the shares of common stock. Shares of common stock cannot be readily sold and there are significant restrictions on the ownership, transferability and repurchase of shares of common stock. If stockholders are able to sell their shares of common stock, they likely would have to sell them at a substantial discount.

• Substantial debt can be incurred, which could hinder the ability to pay distributions to stockholders or could decrease the value of stockholders’ investment if the income from, or the value of, the property securing our debt falls.

• Non-traded REITs rely on advisor entities and their affiliates for day-to-day operations and the selection of investments. They pay substantial fees to advisor entities and their affiliates for these services, and the agreements governing these fees may not be negotiated at arm’s-length. In addition, fees payable to a dealer manager and advisor entities in the organizational stage are based upon the gross offering proceeds and not on the properties’ performance. Such agreements may require them to pay more than they would if they were using unaffiliated third parties.

• Many REIT officers also are principals, officers and/or employees of the advisor, sponsor and other affiliated entities. As a result, the officers will face conflicts of interest, including significant conflicts in allocating time and investment opportunities to the REIT and other similar programs they sponsor.

• If a REIT does not maintain its qualification as a REIT, it would be subject to federal income tax at regular corporate rates, which would adversely affect its operations and ability to pay distributions to our stockholders.

• The amount of distributions paid, if any, is uncertain. Due to the risks involved in the ownership of real estate, there is no guarantee of any return on stockholders’ investment and they may lose money.

• In a rising interest rate environment, treasury securities tend to be more attractive, drawing funds away from REIT’s and lowering share prices.

• REITs pay property taxes, reducing cash flows to shareholders.

• Some dividends are considered ordinary income and therefore usually taxed at a higher rate than the 15% on normal dividends (subject to higher tax rates). Someone in 30% tax bracket who does not need income, would not appear to benefit.

• Fixed income investors traditionally turn to CDs, money market funds and bonds. However, in a low-yield environment, investors may find REITs attractive to the sector’s consistent asset base and steady dividends, which are typically paid monthly.

• Generally, non-traded REITs have suitability requirements of a net worth of at lease $250,000 or a gross annual income of at least $70,000 and a net worth of at least $70,000. However, certain states may have higher suitability requirements.

• REIT investing is intended for any investor who: meets the minimum income and net worth standards; can reasonably benefit from the REIT based on

the overall investment objectives and portfolio structure; is able to bear the economic risk of the investment based their overall financial situation; and has apparent understanding of: i. the fundamental risks of the investment; ii. the risk that the SHAREHOLDER may lose the entire investment; iii. the lack of liquidity of REIT SHARES; iv. the restrictions on transferability of REIT.

Important Considerations


Five Critical Components to Successful REIT Investing

1. Distribution rate alignment with purchase cap

rates

2. Cap rate spread to debt

3. Lease roll/expiration timing with market cycle

4. Portfolio compilation & structural terms

5. Strength Position

1. Lease renewal

2. Revaluation

3. Intended exit


Distribution rate misaligned with purchase cap rates

7% 6.75%

Hypothetical

Purchase

Cap Rate

Hypothetical

Distribution

Rate

Negative

Cushion

Distribution Rate

vs.

Cap Rate

These hypotheticals are for illustrative purposes only and do not necessarily reflect our investment portfolio.

Cap Rate = Net Operating Income Purchase Price


6.5% 8.75%

Hypothetical

Purchase

Cap Rate

Hypothetical

Distribution

Rate

Positive

Cushion

Distribution rate aligned with purchase cap rates


Distribution Rate

vs.

Cap Rate


Interest rate on debt does not add sufficient

accretion/positive leverage

Cap Rate Spread to Debt

4.25

%

8.75

%

Hypothetical

Cap Rate

(Unlevered

Yield)

Hypothetical

Interest Rate

on Debt

Cap

Rate

Spread

450 BP 11.0

%

Effect of

Positive Leverage*

(Levered Yield)

*Assumes 50% leverage



“An understanding of the cap rate spread is an

indispensable real estate operating metric for

understanding dividend sustainability and

expected total return, as the cap rate spread

is the leading indicator for long-term operating

performance for non-listed REITs.”

Source: SeekingAlpha.com



Having lease roll/expiration at an unfavorable

time in a market cycle

• National and/or regional occupancy level decreases

• Generally results in reductions of market rents

• Generally results in landlord-offered rental

concessions

• Generally necessitates payment of un-modeled tenant

improvements and lease conditions

Lease roll/expiration timing with market cycle


Aggressive Portfolio Compilation, Structural

Terms and Investment Philosophy

Over Leveraged

• Effect in down markets – Loss greater than gain

• Lender covenants and restrictions

Use of Higher Risk Assets/Instruments

• Mezzanine debt

• Opportunistic assets

• Reliance on market upturns and recovery

Lease Terms

• Erosion of rental income in gross leases

Portfolio compilation & structural terms


Lack of strength position component at:

1. Lease renewal

2. Interim valuation/revaluation

3. Exit

• Vulnerability to adverse effects of weaker renewal terms

• Lower rent

• Lower net operating income (NOI)

• Failing to combat the negative effects of discounted cash

flow analysis

Strength Position


• A model which structurally disadvantages maximization of

value at exit

• Adjusted funds from operations (AFFO) / earnings before

interest, taxes, depreciation and amortization (EBITDA)

• Multiple/Price/Earnings ratio

• Lack of homogeneous portfolio limiting exit and potentially

limiting valuation:

• Separation of silos

• Potential for cherry picking

• Potentially discounted multiple

• Burden of multiple transactional execution



We believe that financial advisors and investors, today

more than ever, are looking for:

• Preservation and protection of capital

• A reliable and sustainable income stream

• Value sustenance and capital appreciation at exit

Conclusion

Success in REIT investing depends on

choosing a product that includes the five

critical components.

FOR BROKER-DEALER USE ONLY FOR BROKER-DEALER USE ONLY BD-HC216(040113)

Thank you

the five critical components for successful reit investing...for broker-dealer use only...

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